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SOURCES OF FINANCE

CLASSIFICATION OF SOURCES OF FINANCE


According to period
According to ownership According to source of generation

Sources of finance

Security financing

Internal financing

Loan financing

Equity shares Retained earnings Short-term Preference shares Depreciation fund Long-term Debentures

Equity Capital
Unlike debt capital, equity capital is

permanently invested in the business. The business has no legal obligation for repayment of the amount invested or for payment of interest for the use of the funds Share of Ownership Voting Rights Legal Liability Transfer of shares

Preference Shares

Preference shares have a fixed percentage dividend before any dividend is paid to the ordinary shareholders. As with ordinary shares a preference dividend can only be paid if sufficient distributable profits are available, although with 'cumulative' preference shares the right to an unpaid dividend is carried forward to later years. The arrears of dividend on cumulative preference shares must be paid before any dividend is paid to the ordinary shareholders Debentures Debentures are a form of loan stock, legally defined as the written acknowledgement of a debt incurred by a company, normally containing provisions about the payment of interest and the eventual repayment of capital.

Internal financing
Before seeking external sources of capital

from investors or lenders, a business should thoroughly explore all reasonable sources for meeting its capital needs internally. Further, the ability to generate maximum capital internally and to control operations will enhance the confidence of outside investors and lenders. With more confidence in the business and its management, lenders and investors will be more willing to commit their capital.

Retained earnings For any company, the amount of earnings retained within the business has a direct impact on the amount of dividends. Profit re-invested as retained earnings is profit that could have been paid as a dividend. Depreciation fund Controversy whether source of fund or not.

Loan financing Short Term Financing What is Short Term Financing? Short term financing is essentially to provide capital deficit businesses funds for a short term period of a year or less. What is short term financing for? These funds are usually for businesses to run their day-to-day operations including payment of wages to employees, inventory ordering and supplies An example of short tern financing could be when a firm places an order for raw materials, it pays with finance and anticipates to recoup this finance by selling these goods over the period of a year.

Examples of Short Term financing sources There are many methods for which a firm can seek short terms financing some of these include: Overdrafts Short-term loans Bills of exchange Promissory notes/commercial paper Inventory loan Letters of credit Short term Eurocurrency advances . Factoring . Commercial papers

Long Term Financing


What is long term financing? Long term financing provide capital deficit

businesses funds for the period over 1 year. It contrasts to short term financing because short term financing provides funds for the period of 1 year or less
What is Long-Term Debt Financing used for can include: Fixed Assets Large Capital Equipment Purchases Large Scale Construction Projects Expansion of Facilities

Where does the financing come from?


The basic sources of long term financing

products depending on the business entity are from: Debt Equity

Debt Capital
Debt capital is an amount of money borrowed

from a creditor. The amount borrowed is usually evidenced by a note, signed by the borrower, agreeing to repay the principal amount borrowed plus interest on some predetermined basis. Borrowing Term
The terms under which money is borrowed may vary widely. Short-term notes can be issued for periods as brief as 10 days to fill an immediate need. Long-term notes can be issued for a period of several years.

Payment Schedule
When the terms of a debt are negotiated, a payment schedule is established for both interest obligations and principal repayment.

Discounted Notes
In some cases, particularly in short-term borrowing, the total amount of interest due over the term of the note is deducted from the principal before the proceeds are issued to the borrower. Such a note is called a discounted note.

Short-term Borrowing
Short-term borrowing usually requires

repayment within 60 to 90 days. Notes are often renewed, in whole or in part, on the due date, provided that the borrower has lived up to the obligations of the original agreement and the business continues to be a favorable lending risk.

Long-term Debt
Long-term debt is borrowing for a period

greater than one year. This general classification includes "intermediate debt" which is borrowing for periods of one to 10 years.

Bank lending
Borrowings from banks are an important source of

finance to companies. Bank lending is still mainly short term, although medium-term lending is quite common these days. Short term lending may be in the form of: a) an overdraft, which a company should keep within a limit set by the bank. Interest is charged (at a variable rate) on the amount by which the company is overdrawn from day to day; b) a short-term loan, for up to three years. - Purpose - Amount - Repayment - Term - Security

Leasing
A lease is an agreement between two parties,

the "lessor" and the "lessee". The lessor owns a capital asset, but allows the lessee to use it. The lessee makes payments under the terms of the lease to the lessor, for a specified period of time. Leasing is, therefore, a form of rental. Leased assets have usually been plant and machinery, cars and commercial vehicles, but might also be computers and office equipment

Hire purchase Hire purchase is a form of instalment credit. Hire purchase is similar to leasing, with the exception that ownership of the goods passes to the hire purchase customer on payment of the final credit instalment, whereas a lessee never becomes the owner of the goods. Hire purchase agreements usually involve a finance house. i) The supplier sells the goods to the finance house. ii) The supplier delivers the goods to the customer who will eventually purchase them. iii) The hire purchase arrangement exists between the finance house and the customer.

Venture capital
Venture capital is money put into an

enterprise which may all be lost if the enterprise fails. A businessman starting up a new business will invest venture capital of his own, but he will probably need extra funding from a source other than his own pocket. However, the term 'venture capital' is more specifically associated with putting money, usually in return for an equity stake, into a new business, a management buy-out or a major expansion scheme.

Franchising
Franchising is a method of expanding business on

less capital than would otherwise be needed. For suitable businesses, it is an alternative to raising extra capital for growth. Franchisors include Budget Rent-a-Car Mac Donalds and Chicken Inn. Under a franchising arrangement, a franchisee pays a franchisor for the right to operate a local business, under the franchisor's trade name. The franchisor must bear certain costs (possibly for architect's work, establishment costs, legal costs, marketing costs and the cost of other support services) and will charge the franchisee an initial franchise fee to cover set-up costs, relying on the subsequent regular payments by the franchisee for an operating profit. These regular payments will usually be a percentage of the franchisee's turnover